Lululemon stock drops as yoga pants expose problems

March 19, 2013|Reuters

Shares of Lululemon Athletica Inc slid on Tuesday after the trendy retailer said it was recalling batches of pants it called too transparent, an embarrassment that raised fresh questions about whether it could sustain its stellar growth.

Late on Monday, Lululemon said it was pulling from its store shelves about 17 percent of the women's black pants made with its signature stretchy "Luon" fabric because the products fell short of technical specifications.

It warned that the recall of the see-through pants would have a significant impact on financial results.

The episode, the second quality issue disclosed in less than a year, could undermine Lululemon's reputation, said analysts who noted that competition from lower-priced brands is heating up. Last July, the company acknowledged problems with dye-bleeding in some of its apparel.

"Those are two black eyes for a brand that is supposed to stand for quality in the marketplace," said Brian Sozzi, chief equities analyst at NBG Productions. "It's a window of opportunity for Lululemon competitors."

Sales growth in established stores is now expected to come in at 5 percent to 8 percent for the current quarter, sharply off the 11 percent growth it had expected up to March 17 and a far cry from the 25 percent growth it posted a year earlier.

The supplier, Taiwan's Eclat Textile Co Ltd, said it had followed Lulu's specifications for the pants, and that the retailer had apparently misjudged customer tastes.

Lululemon, due to report earnings for its fiscal fourth quarter to Feb. 3 on Thursday, had no immediate comment beyond its statement late Monday.

REPUTATION FOR QUALITY

Shares of Lululemon dropped more than 4 percent on the Toronto Stock Exchange on Tuesday as analysts trimmed their expectations. By late afternoon, the stock was down 3.3 percent at C$65.29.

With the recalled products off the market, Sozzi said, customers will be tempted to check out similar offerings from Nike Inc and Gap Inc's Athleta banner.

Sterne Agee analyst Sam Poser downgraded the stock to "neutral" from "buy," advising clients to "wait and see" while the problem is resolved. The company has not said when it would have the affected products in stock.

"The potential problem you have is that if the customer walks in and can't find that pant, and she can't find it for six weeks, she might end up saying: ‘Oh, well, I'll try Under Armour, or I'll try Nike, or I'll try whomever,'" said Poser.

Lululemon has carved out a profitable niche selling fashionable, pricey workout gear to women. One of very few Canadian retailers to succeed in the United States, the chain is expanding in Europe and Asia over the next two years, and it has small but growing lines for men and girls.

Investors are split on whether its rapid growth can keep pace with lofty expectations as more rivals, such as Athleta, muscle into its territory, offering similar gear at lower prices.

"DO A COUPLE OF DOWN DOGS"

Customers may find that some Lululemon products still on sale are partially transparent as well.

"You may experience sheerness with some of our bright-colored bottoms because of the lightweight nature of the fabric," says a disclaimer on some product pages on the company's website.

"We recommend you do a couple of Down Dogs in your bright-colored bottoms to ensure you're happy with the fit and coverage," the page reads, referring to a basic yoga position.

The company said the products in question were available starting March 1, but user reviews on its website called attention to earlier problems with see-through fabric.

On the U.S. site, most reviews for the "Wunder Under Crop", pants are positive. But some customers complained the pants are see-through: "When you bend over, your knickers are clearly visible," wrote a reviewer in August. (http://bit.ly/WTJnaU)

Because the reviewers are not asked for their full names, their comments are impossible to verify. But there are similar comments on many products.

SUPPLIER SPEAKS OUT

Eclat, a longstanding Lululemon supplier that manufactures Luon, told Reuters that "a gap between Lululemon's expectations and reaction from the market" was the cause of the problem.

"We checked our orders this morning and indeed, we did follow their instructions to make the product," said Roger Lo, a spokesperson at Eclat. "Lulu has some new ideas every year, such as taking different approaches for fashion-related purposes."

Shares of Eclat fell 1.6 percent in Taipei on Tuesday, lagging a 0.4 percent gain in the benchmark TAIEX index.

In its annual report in March 2012, Lululemon said it was at risk of overly relying on a limited number of suppliers. It said Luon was supplied by a single manufacturer in Taiwan.

Still, it was not immediately clear whether Eclat manufactured all of the fabric that prompted the recall, or if another manufacturer was also involved.

CUTS SALES FORECAST

Lululemon said it now expected to report fiscal first-quarter sales of $333 million to $343 million, down from its prior forecast of $350 million to $355 million. The company is trying to determine the impact on first-quarter earnings, as well as the expected impact on results for the rest of 2013.

International Strategy and Investment Group analyst Sam Lee said in a note to clients that Lululemon's woes are due to teething issues in an immature supply chain.

"We would really like to see the company more aggressively invest in and exercise greater control over its supply chain given the importance of quality and consistent fit to the Lulu brand promise," said Lee. He added that the pullback in Lulu's stock still presented a buying opportunity.